1. © 2003 The McGraw-Hill Companies, Inc. All rights reserved. Prepared by Anne Inglis, Ryerson University Cash and Liquidity Management Chapter Nineteen

2. 19.1 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Key Concepts and Skills Understand how firms manage cash Understand float Understand how to accelerate collections and manage disbursements Understand the characteristics of various short-term securities Appendix: Be able to use the BAT and Miller- Orr models and understand the different assumptions

3. 19.2 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Chapter Outline Reasons for Holding Cash Determining the Target Cash Balance Understanding Float Investing Idle Cash Appendix – Cash Management Models

4. 19.3 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Reasons for Holding Cash 19.1 Speculative motive – hold cash to take advantage of unexpected opportunities Precautionary motive – hold cash in case of emergencies Transaction motive – hold cash to pay the day-to-day bills Trade-off between opportunity cost of holding cash relative to the transaction cost of converting marketable securities to cash for transactions

5. 19.4 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Target Cash Balance 19.2 A firm’s desired cash level as determined by the trade-off between carrying costs and shortage costs Adjustment costs (shortage costs) – costs associated with holding too little cash

6. 19.5 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Understanding Float 19.3 Float – difference between cash balance recorded in the cash account and the cash balance recorded at the bank Disbursement float –Generated when a firm writes cheques –Available balance at bank – book balance > 0 Collection float –Cheques received increase book balance before the bank credits the account –Available balance at bank – book balance < 0 Net float = disbursement float + collection float

7. 19.6 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Quick Quiz I You have $5000 in your checking account. You just received a check of $2000 and wrote a check for $2500. –What is the disbursement float? –What is the collection float? –What is the net float? –What is your book balance? –What is your available bank balance?

8. 19.7 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Example: Measuring Float Size of float depends on the dollar amount and the time delay Delay = mailing time + processing delay + availability delay Suppose you mail a check for $1000 and it takes 3 days to reach its destination, 1 day to process and 1 day before the bank will make the cash available What is the average daily float (assuming 30 day months)? –Method 1: (3+1+1)(1000)/30 = 166.67 –Method 2: (5/30)(1000) + (25/30)(0) = 166.67

9. 19.8 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Example: Cost of Float Cost of float – opportunity cost of not being able to use the money Suppose the average daily float is $3 million with a weighted average delay of 5 days. –What is the total amount unavailable to earn interest? 5*3 million = 15 million –What is the NPV of a project that could reduce the delay by 3 days if the cost is $8 million? Immediate cash inflow = 3*3 million = 9 million NPV = 9 – 8 = $1 million

10. 19.9 Copyright © 2005 McGraw-Hill Ryerson Limited. All rights reserved. Cash Collection Payment PaymentPayment Cash Mailed ReceivedDeposited Available Mailing TimeProcessing DelayAvailability Delay Collection Delay One of the goals of float management is to try and reduce the collection delay. There are several techniques that can reduce various parts of the delay.